Question

Santana Rey, owner of Business Solutions, realizes that she needs to begin accounting for bad debts expense. Assume that Business Solutions has total revenues of \(44,000 during the first three months of 2018 and that the Accounts Receivable balance on March 31, 2018, is \)22,867.

Required

1. Prepare the adjusting entry needed for Business Solutions to recognize bad debts expense on March 31, 2018, under each of the following independent assumptions (assume a zero unadjusted balance in the Allowance for Doubtful Accounts at March 31).

a. Bad debts are estimated to be 1% of total revenues. (Round amounts to the dollar.)

b. Bad debts are estimated to be 2% of accounts receivable. (Round amounts to the dollar.)

2. Assume that Business Solutions’s Accounts Receivable balance at June 30, 2018, is \(20,250 and that one account of \)100 has been written off against the Allowance for Doubtful Accounts since March 31, 2018. If S. Rey uses the method prescribed in part 1b, what adjusting journal entry must be made to recognize bad debts expense on June 30, 2018?

3. Should S. Rey consider adopting the direct write-off method of accounting for bad debts expense rather than one of the allowance methods considered in part 1? Explain

Short answer

1. The amount of bad debt expense will be as follows:

1. $440
2. $457
3. The amount ofbad debt expense as of June 30, 2018, will be $48.
4. No, Santana S. Rey should not consider adopting the direct write-off method of accounting.

Step-by-step solution

Step-by-Step SolutionStep 1: Meaning of Bad Debt

A bad debt refers to an amount of receivable, which is now irrecoverable from the customers because of their inability to repay.

Journal entries

Part a

Date	Particulars	Debit ($)	Credit ($)
March 31	Bad debt expense $\left(\$44,000\times 1\%\right)$	440
	Allowance for doubtful accounts		440
	(To record the bad debt expense)

Part b

Date	Particulars	Debit ($)	Credit ($)
March 31	Bad debt expense $\left(\mathbf{\$}\mathbf{22}\mathbf{,}\mathbf{867}\mathbf{\times }\mathbf{2}\mathbf{\%}\right)$	457
	Allowance for doubtful accounts		457
	(To record the bad debt expense)

Adjusting journal entry

Date	Particulars	Debit ($)	Credit ($)
a	Bad debt expense	48
	Allowance for doubtful accounts		48
	(To record the bad debt expense)

Working notes:

Particulars	Amount
Balance in allowance for doubtful accounts on March 31, 2018	$457
Less: Written-off amount	$100
Balance in allowance for doubtful accounts on June 30, 2018	$357

Particulars	Amount
Balance in allowance for doubtful accounts on June 30, 2018 $\left(\$20,250\times 2\%\right)$	$405
Less: Balance in allowance for doubtful accounts on June 30, 2018	$357
Bad debt expense	$48

Reason

Santana S. Rey should not consider adopting the direct write-off method of accounting to adjust the balance of bad debt expenses. In part 1, they assume the bad debts of 1% of the total revenues and 2% of accounts receivables. Since they think these are possible bad debts, the company can suffer. They are matched with their relative credit sales in the same accounting period.